Option contracts

A futures contract is an agreement that calls for a seller to deliver to a buyer a specified quantity and quality of an identified commodity, at a fixed time in the future, at a price agreed to when the contract is made. An option on a commodity futures contract gives the buyer of the option the right to convert the option into a futures contract. Energy futures and options contracts arc used by energy producers, petroleum refin-... 

Wliatever the item, such as crude oil, underlying the futures or options contract, evei y market needs certain ingredients to flourish. These include... 

NYMEX New York Mercantile Exchange, Inc. (NYMEX Exchange). The company is a major provider of financial services to the energy and metals industries including the trading of energy futures and options contracts. 

A separate consideration needs to be made for inventory, which in principle is used to be able to uncouple procuring from manufacturing and sales. In this regard it is mostly considered as a risk hedging strategy that increases costs. Finally, contracts, especially option contracts and futures, are other risk hedging tools. 

Barbaro and Bagajewicz (2004b) introduced specific constraints that can be used in the context of two-stage stochastic investment planning models. Similarly to fixed contracts, the usual assumption that option contracts hedge risk automatically at low profit levels is not always true. Specific risk management is required. 

Barbaro A.F. and Bagajewicz M. 2004b. Use of inventory and option contracts to hedge financial risk in planning under uncertainty, AIChE J., 50(5), 990-998. 

Gupta A. and Maranas C. 2003b. Market-based pollution abatement strategies risk management using emission option contracts, Ind. Eng. Chem. Res., 42, 802-810. 

An equilibrium model of the term structure, of which we reviewed three in the previous section, is a model that is derived from (or consistent with) a general equilibrium model of the economy. They use generally constant parameters, including most crucially a constant volatility, and the actual parameters used are often calculated from historical time series data. Banks commonly also use parameters that are calculated from actual data and implied volatilities, which are obtained from the prices of exchange-traded option contracts. 

In this section we will explore exchange-traded interest rate options— contracts traded on organised exchanges. In contrast, OTC options offered by banks will be examined in the next section. 

Eurex offers three principal bond option contracts, all of these being options on the futures contracts traded on the same exchange. The contracts available are ... 

Each of these is an option on the underlying futures. If an investor exercises one call option contract, he or she will be assigned a long position of one contract in the underlying future, at the strike price. Equally, after exercising one put option contract, an investor will be assigned a... 

Trading in these bond options contracts is extensive across the bond maturity spectrum, averaging at over 200,000 contracts per day dnring January 2003, as the monthly statistics in Exhibit 17.5 shows. The total open interest in bond options, amounting to around 2 million contracts, represents an underlying position of 200 billion. 

As with bond options, each of these options contracts are exercisable into one contract in the underlying futures, also traded on the same exchange. The detailed specifications for EURIBOR STIR options are given in Exhibit 17.11, with those for the other currencies being very similar. However, as the EURIBOR contracts are the most liquid, we will concentrate on these for the remainder of this section. 

EXHIBIT 18.1 Euro-Bund Option Contract Specification... 

Bonds. Exchange-traded options on bonds are invariably written on the bonds futures contracts. One of the most popular exchange-traded options contracts, for example, is the Treasury bond option, which is written on the Treasury futures contract and traded on the Chict o Board of Trade Options Exchange. Options written on actual bonds must be traded in the OTC market. 

The values of forward, futures, and option contracts are all functions of the futures price F(t,T), as well as of additional variables. So the values at time r of a forward, a futures, and an option can be expressed, respectively, asf F,t), u F,t), and C F,i). Since the value of a forward contract is also a function of the price of the underlying asset S at time T, it can be represented hy f F,t,S,T). Note that the value of the forward contract is not the same as its price. As explained in chapter 12, a forward s price, at any given time, is the delivery price that would result in the contract having a zero present value. When the contract is transacted, the forward value is zero. Over time both the price and the value fluctuate. The futures price... 

Options price sensitivity is different from that of other financial market instruments. An option contract s value can be affected by changes in any one or any combination of the five factors considered in option pricing models (of course, strike prices are constant in plain vanilla contracts). In contrast, swaps values are sensitive to one variable only—the swap rate—and bond futures prices are functions of just the current spot price of the cheapest-to-deliver bond and the current money market repo rate. Even more important, unlike for the other instruments, the relationship between an option s value and a change in a key variable is not linear. 

Xu, H. 2010. Managing production and procurement through option contracts in supply chains with random yield. International Journal of Production... 

The call option in a supply chain works as follows. At the beginning of the period, the retailer places an order of quantity Q, paying a price W for each unit. She also purchases q (call) option contracts from the supplier (at a price c per contract). She now has the right to purchase up to q additional units at the end of the period after demand is realized, at a cost w per unit (exercise price of the option). Under this arrangement, the supplier is committed to produce Q + q units, but can salvage any unexercised options at the end of the period. Thus, the call option transfers some risk from the buyer to the supplier. In scenarios where production lead time is high the buyer must place her order early, so that some uncertainty still remains when the call option is exercised. In this situation, a combination of call and put options can be employed (Erkoc and Wu 2005) that incorporates a put option when the call option is exercised the buyer has the right to return excess orders to the supplier after all demand uncertainty is resolved. 

FIGURE 8.2 Payoff Profiles for Long and Short Positions in a Call Option Contract ... 

Measured by the volume of LME turnover (see Table 16.1), the market in aluminium is currently the largest, followed by copper, and then zinc. In tonnage terms, lead is now a rather poor fourth, while measured by the number of lots traded, it falls behind nickel as well. Volume statistics such as those in Table 16.1 measure trading activity in terms of the number of futures (or options) contracts that are either bought or sold over a given period (in this case a year). 

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